Case – 7-1 Primus Consulting
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Background
Primus is a consulting firm that focuses on process reengineering and quality improvement initiatives. Northwood Industries, a potential client, has asked Primus to perform a study at a fee rate lower than the normal standards. Historically Primus has billed clients for consulting time at standard flat rates plus actual travel costs and estimated overhead. Primus is considering accepting the job because it has capacity (i.e. available staff) to take on the new contract with out having to hire any new employees.
Issues
Primus has to determine if engaging in a project, that is estimated to create a net loss of $9,000, is a good decision. What will be the overall effect to P/L to Primus if they accept the contract? Analyzing Primus cost structure, what can be considered to help justify our decision of accepting verses rejecting the offer?
Analysis
If we analyze Primuss cost structure (Exhibit 1) we can determine that Primus would have travel costs of $15,000. Based on the information provide overhead is calculated at the beginning of the year from an annual overhead budget of $1,600,000 divided by the total estimated non-partner hours of 8,000 and apply 10% to calculate the variable costs. As calculated in Exhibit 2, we have determined that variable costs equal $800. Thus if Primus accepts the contract, they will earn an incremental profit of $69,000.
Conclusion
Before accepting or rejecting the job with Northwood Industries, Primus has to first consider a few qualitative factors. By accepting the contract Primus has the opportunity to perform a service to a brand new client. Even thought Primus is not able to charge its normal market rate, this one job can lead to other more profitable jobs down the road with Northwood or with some of Northwoods affiliates. On the flip side of the argument, should Primus accept the contact they could in fact be setting an negative precedent. If other potential clients or existing clients hear of the discounted rate Northwood received, they too will demand a much lower rate. This could lead to more unprofitable deals which could force Primus out of business.
Based on the analysis form both Exhibit 1 & 2, we have conclude that the present contract at $85,000 will cover all variable costs. Since Primus has the available capacity, meaning